My late grandmother once said: “They didn’t have cholesterol when I was a girl!” in response to some family member trying to discourage her from cooking with Crisco. It became a family joke, but we can all relate to food facts that come and go. When I was a girl, we were not supposed to eat too many eggs. Now, eggs are the wonder food and that is totally OK because they have “good” cholesterol. Red meat was necessary to prevent anemia, then it was to be eaten only in moderation. Now, it seems the jury may be back out for recess. Dark chocolate, coffee, red wine, beer, nuts, carbohydrates in general, monosaturated and polyunsaturated fats in particular—are they good for us or not? We all want to eat right with a goal of fully enjoying our senior years, but it is difficult when the play-by rules keep changing.

Financial planning is somewhat analogous to healthy eating. We try to do the right things about saving, while we are working, so that we can have a financially healthy retirement and, perhaps, leave a legacy. These goals are even more important to parents, who have a child with a disability significant enough that s/he is going to continue to require substantial support throughout her/his adult life. (image is cholesterol molecule.)
We, the general working public, have been educated to believe it is crucial to save money for our retirement via a 401(k) plan or similar, if we have access to one through our employers, or through an Individual Retirement Account (IRA), or some variation thereof if we do not. Self-employed individuals can learn how to open a SIMPLE (Savings Incentive Match Plan for Employees) IRA, A SEP (Simplified Employee Pension) IRA, or a “Solo K” (401(k) for one participant). All these plans allow the worker to save pre-tax funds and invest them over time to fund her/his future retirement. The strategy is to lower the worker’s tax burden while s/he is working, paying a mortgage, raising children, etc. and delay paying tax on the saved income until retirement, when the worker may be in a lower tax bracket or, at least, in a more flexible position to manage expenses and taxes.
For many workers and their families, saving into these types of tax-deferred retirement plans is a sound and workable strategy. However, there are some drawbacks. Because the IRS wants its tax cut and because the agency cannot collect taxes until the funds are withdrawn from the tax-deferred retirement plan, owners are required to begin withdrawing funds at a certain age (currently 72) and paying taxes whether or not they need the funds. Since the amount required to be withdrawn—called the “required minimum distribution” or “RMD”—is calculated by dividing the previous end-of-year balance by a factor, derived from the owner’s remaining expected years of life—the mandated withdrawal amount for large accounts can be way in excess of what the owner actually needs to cover living expenses. As a result, the owner is forced to pay taxes on those funds prematurely.
Until January of 2020, heirs who inherited an IRA were also permitted to withdraw the account balance gradually over their entire remaining lifespan. The questionably named “Setting Every Community Up for Retirement Enhancement” or “SECURE” Act did away with this so-called “stretch” characteristic for beneficiaries other than the owner’s spouse or child with a disability. Anyone else needs to fully withdraw the funds within 10 years—and pay the resulting taxes. This means that workers, who accumulated large or large-ish tax-deferred accounts, not only pay tax early on their own withdrawals but may set up their heirs for ten years of income spikes that will drive them into an unnecessarily high tax bracket.
Even though a child or an adult child with a disability, who inherits from a parent a tax-deferred retirement account is exempt from the 10-year withdrawal schedule, parents of children with disabilities face a unique set of circumstances, when it comes to bequeathing tax-deferred retirement accounts. Most parents are aware that they should not bequeath any financial assets, including a retirement account, directly to their son or daughter with a disability, at least if that person is accessing or may need to access public means-tested benefits (such as Supplemental Security Income (SSI), Medicaid, or the adult support and long-term care services which are primarily funded by Medicaid waivers). This is because these benefits impose a limit on the countable resources that the recipient may own. Retirement accounts are definitely a countable resource.
However, what some parents may not consider is that means-tested benefits also impose a limit on the amount of income that the recipient may receive and still remain eligible. The limit is particularly strict for unearned income, which would include distributions from a retirement account. This causes a conundrum, even when a special needs trust for the benefit of the adult child with a disability becomes the owner of the retirement account because each distribution from a traditional retirement account such as an IRA, is income taxable at ordinary income-tax rates. In the case of a special-needs trust, income may be retained in the trust and taxed to the trust, or it may be “passed through” to the beneficiary and taxed to the beneficiary. If a sizeable IRA generates a sizeable required distribution, and that distribution is retained by the trust, it may be taxed at a high rate, since trust- income tax brackets are quite condensed, compared to those of individuals. Trust income between $2650 and $9,950 is taxed at 24%, income between $9,950 and $13,050 is taxed at 35%, and income over that at 37%. Many people with disabilities, who require a special needs trust to maintain their benefits, have relatively low income and in turn a relatively low individual marginal tax rate. However, income distributed from an IRA and “passed through” to them might very well be enough to make them ineligible for means-tested benefits.
If the grantors are still alive and relatively young, they can take corrective measures to avoid the future challenges of leaving a traditional retirement account to their child’s special needs trust. Many corporate retirement plans now offer a Roth option, meaning that parents can make some or all of their retirement contributions as Roth. Since Roth contributions are after-tax and since distributions from Roth accounts are not taxable, this strategy avoids those challenges. Parents, who lack a Roth 401(k) option, might consider contributing to a Roth IRA separately, if their income is not too high or using a “Back-door Roth” strategy if their income is too high. Parents, who are approaching retirement, might consider delaying their Social Security filing until their age 70 and using low-income years between retirement and their Social Security collection to convert some of their traditional retirement assets to Roth.
Research can help you clarify what habits can benefit your overall health, like monitoring “bad” cholesterol. Research can also help you clarify what healthy habits, practiced now, can help you have a healthy and active retirement. Understanding the future implications of the retirement-savings choices you make now can help your heirs, including your child with a disability, have a healthier and less complicated tax future.
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